Tax Court Denies Deduction for Facade Easement

Tax Court Denies Deduction for Facade Easement

Summary

The Tax Court has denied a couple's claimed income tax charitable deduction for a facade easement based on the fact they failed to raise any genuine issue of material fact regarding their compliance with the regulations.

In 2003, Ps transferred a facade easement and cash to a qualified
organization. With respect to the facade easement contribution, Ps
claimed a charitable
contribution deduction in 2003 and a corresponding carryover deduction
in 2004; with respect to the cash contribution, Ps claimed a charitable
contribution deduction in 2003. R disallowed the deductions, which led
to deficiencies. R also determined accuracy-related penalties under sec.
6662, I.R.C.

R has moved for summary judgment. Ps object.

1. Held: With respect to the facade easement contribution,
Ps have failed to raise any genuine issue of material fact regarding
their compliance with sec. 1.170A-14(g)(6)(ii), Income Tax Regs. Because
the facade easement contribution fails to satisfy the requirement in
that provision, the interest in property conveyed by the facade easement
was not protected in perpetuity. Thus, the facade easement contribution
was not a qualified conservation contribution under sec. 170(h),
I.R.C., see sec. 170(h)(2)(C), (5)(A), I.R.C., and Ps are not entitled
to any deduction therefor, see sec. 170(f)(3), I.R.C.

2. Held, further, Ps have raised genuine issues of
material fact with respect to the cash contribution and the
accuracy-related penalties under sec. 6662(a), I.R.C.

In 2003, petitioners contributed a facade easement and cash to the
National Architectural Trust (NAT). With respect to the facade easement
contribution, petitioners claimed a charitable contribution
deduction in 2003 and a corresponding carryover deduction in 2004; with
respect to the cash contribution, they claimed a charitable contribution
deduction in 2003. Respondent disallowed those deductions, which led to
the deficiencies. With respect to the portions of the underpayments of
tax in 2003 and 2004 attributable to the facade easement contribution,
respondent determined accuracy-related penalties of 40 percent for a
gross valuation misstatement under section 6662(h); in the alternative,
he determined accuracy-related penalties of 20 percent2 for
negligence, substantial understatement of income tax, and substantial
valuation misstatement under section 6662(a). With respect to the
portion of the underpayment of tax in 2003 attributable to the cash
contribution, respondent determined an accuracy-related penalty of 20
percent for negligence and substantial understatement of income tax
under section 6662(a).

Respondent has moved for summary judgment (the motion).
Petitioners object (the response). At our request, petitioners also
filed a supplement to the response (the supplement). We shall grant the
motion only with respect to the facade easement contribution. With
respect to the cash contribution and the penalties, we shall deny the
motion.

BACKGROUND

At the time they filed the petition, petitioners lived in
Massachusetts. The property here in question is a single-family rowhouse
located in a historic preservation district in Boston. In December
2003, petitioners entered into a preservation restriction agreement (the
agreement) with NAT pursuant to which petitioners granted to NAT a
facade easement restricting the use of the property. NAT also required
petitioners to make a cash contribution, calculated as a percentage of
the estimated value of the facade easement, to provide for "monitoring
and administration" of the facade easement. Later that month,
petitioners contributed $16,840 to NAT,3 and NAT accepted the
agreement. At the time of the contributions, Washington Mutual Bank, FA
(the bank), held a mortgage on the property.

On their 2003 Federal income tax return, petitioners claimed a charitable
contribution deduction of $220,800 for the contribution of the facade
easement. Because of the limitations on charitable contribution
deductions in section 170(b)(1)(C), petitioners claimed a charitable contribution deduction with respect to the facade easement of only
$103,377. Petitioners also claimed a charitable contribution
deduction of $16,870 for the cash contribution, notwithstanding that the
cash contribution was only $16,840.

On their 2004 Federal income tax return, petitioners claimed
a carryover charitable
contribution deduction of $117,423 related to the facade easement
contribution.

DISCUSSION

I. Introduction

We may grant summary judgment "if the pleadings, answers to
interrogatories, depositions, admissions, and any other acceptable
materials, together with the affidavits, if any, show that there is no
genuine issue as to any material fact and that a decision may be
rendered as a matter of law." Rule 121(b). In pertinent part, Rule
121(d) provides: "When a motion for summary judgment is made and
supported * * *, an adverse party may not rest upon the mere allegations
or denials of such party's pleading, but such party's response * * *
must set forth specific facts showing that there is a genuine issue for
trial."

Section 170 allows a deduction for any charitable contribution,
subject to certain limitations, that the taxpayer makes during the
taxable year. In general, section 170(f)(3) denies any deduction for a
contribution of an interest in property that is less than the taxpayer's
entire interest in the property. One exception to that general rule,
however, is for a qualified conservation contribution. Sec.
170(f)(3)(B)(iii). Under section 170(h)(1), a qualified conservation
contribution must be a contribution of a "qualified real property
interest * * * exclusively for conservation purposes."4 The
interest in property conveyed by a facade easement must be protected in
perpetuity for the contribution of the easement to be a qualified
conservation contribution. Under section 170(h)(2)(C), a qualified real
property interest must be "a restriction (granted in perpetuity) on the
use which may be made of the real property." See also sec.
1.170A-14(b)(2), Income Tax Regs. Under section 170(h)(5)(A), "A
contribution shall not be treated as exclusively for conservation
purposes unless the conservation purpose is protected in perpetuity."
See also sec. 1.170A-14(a), Income Tax Regs.

If the facade easement was not protected in perpetuity, then its
contribution was not a qualified conservation contribution, and
petitioners are not entitled to any deduction therefor. Section
1.170A-14(g)(6)(ii), Income Tax Regs., requires that, at the time of the
gift, the donor must agree that the donation of the perpetual
conservation restriction gives rise to a property right, immediately
vested in the donee organization, with a fair market value that, at the
time of the gift, is at least equal to the proportionate value that the
perpetual conservation restriction bears to the value of the property as
a whole. Moreover, section 1.170A-14(g)(6)(ii), Income Tax Regs.,
states in pertinent part:

when a change in conditions give rise to the extinguishment of a
perpetual conservation restriction * * *, the donee organization, on a
subsequent sale, exchange, or involuntary conversion of the subject
property, must be entitled to a portion of the proceeds at least equal
to that proportionate value of the perpetual conservation restriction * *
*

Petitioners concede that the property had a mortgage and that the
bank retained a "prior claim" to all proceeds of condemnation and to all
insurance proceeds as a result of any casualty, hazard, or accident
occurring to or about the property. Moreover, petitioners do not dispute
that the bank was entitled to those proceeds "in preference" to NAT
until the mortgage was satisfied and discharged. The right of NAT to its
proportionate share of future proceeds was thus not guaranteed.
Petitioners argue that whether NAT would receive its proportionate share
of any proceeds is a question of fact. In effect, petitioners argue
that they have satisfied the requirement in section 1.170A-14(g)(6)(ii),
Income Tax Regs., because NAT might be entitled to its
proportionate share of future proceeds. Yet that provision states that
the donee organization must be so entitled. See id. The
requirement is not conditional. Petitioners cannot avoid the strict
requirement in section 1.170A-14(g)(6)(ii), Income Tax Regs., simply by
showing that they would most likely be able to satisfy both their
mortgage and their obligation to NAT. The facade easement contribution
thus fails to satisfy the requirement in section 1.170A-14(g)(6), Income
Tax Regs., and so fails to satisfy the enforceability in perpetuity
requirement under section 170(h)(2)(C) and (5)(A).

The facade easement contribution thus fails as a matter of law
to comply with the enforceability in perpetuity requirements under
section 1.170A-14(g), Income Tax Regs. For that reason, we find that the
facade easement contribution was not protected in perpetuity and so was
not a qualified conservation contribution under section 170(h)(1).5
We shall grant the motion with respect to the facade easement
contribution.

III. The Cash Contribution

Respondent argues that we should disallow the charitable contribution
deduction for the cash contribution for two reasons. First, respondent
argues that the cash contribution was a conditional gift and so violated
section 1.170A-1(e), Income Tax Regs. Second, respondent argues that
the cash contribution was part of a quid pro quo and so violated the
rule of Hernandez v. Commissioner, 490 U.S. 680 (1989).
Petitioners, however, raise genuine issues of material fact with respect
to both arguments.

First, section 1.170A-1(e), Income Tax Regs., states:

If as of the date of a gift a transfer for charitable purposes is
dependent upon the performance of some act or the happening of a
precedent event in order that it might become effective, no deduction is
allowable unless the possibility that the charitable transfer will not
become effective is so remote as to be negligible. * * *

In neither the response nor the supplement do petitioners dispute
that the cash contribution was a conditional gift; that is, petitioners
seem to concede that the agreement required NAT to refund the cash
contribution if the appraisal found the facade easement to have no
value.

Petitioners, however, rely on the exception (quoted above) in
section 1.170A-1(e), Income Tax Regs. They argue that the possibility
that the charitable
transfer would not become effective -- that is, the possibility that
the appraisal would find the facade easement to have no value -- was "so
remote as to be negligible." See id. Moreover, according to
petitioners, that inquiry is inherently factual. We agree.

Second, under Hernandez v. Commissioner, supra,
a transfer is not a charitable contribution if it is part of a
quid pro quo. Respondent argues that the cash contribution was payment
for a service. Respondent seems to argue that, in return for the cash
contribution, NAT accepted the facade easement contribution so that
petitioners could claim a charitable contribution deduction. Even if
NAT required petitioners to make the cash contribution, however, we are
not convinced that that is sufficient to deny a charitable contribution
deduction under Hernandez.6

Because petitioners raise genuine issues of material fact
regarding the cash contribution, we shall deny the motion with respect
to the cash contribution.

IV. Accuracy-Related Penalties

Respondent concedes that "if the facade easement contribution is
disallowed as a matter of law * * *, the gross misstatement valuation
(and the substantial valuation misstatement) penalties would not apply."
We accept his concession. For both the facade easement contribution and
the cash contribution, we must decide only whether to sustain the
accuracy-related penalties of 20 percent for negligence and substantial
understatement of income tax under section 6662(a). Because petitioners
raise genuine issues of material fact regarding the applicability of the
reasonable cause defense to the penalties, we must deny the motion with
respect to those penalties.

Section 6664(c)(1) provides that the accuracy-related penalty
shall not be imposed with respect to any portion of an underpayment if
the taxpayer shows that there was reasonable cause for that portion and
the taxpayer acted in good faith with respect to that portion. Further:

The determination of whether a taxpayer acted with reasonable cause and
in good faith is made * * * case-by-case * * *, taking into account all
pertinent facts and circumstances. * * * Reliance on * * * professional
advice * * * constitutes reasonable cause and good faith if, under all
the circumstances, such reliance was reasonable and the taxpayer acted
in good faith. * * *

Sec. 1.6664-4(b)(1), Income Tax Regs.; see also sec. 1.6664-4(c), Income
Tax Regs. ("Reliance on opinion or advice").

Respondent argues that petitioners may not, as a matter of law,
rely on the reasonable cause exception.7 In so concluding,
respondent relies on communications between Mr. Kaufman and a
representative of NAT that suggest Mr. Kaufman had reason to believe the
facade easement in fact had no value. Petitioners assert that the
significance of those communications must be determined in the light of
all the relevant facts and circumstances, and we agree. Petitioners
argue that they relied on the advice of their accountant. Petitioners
argue that at trial (1) their accountant would testify to show that they
had reasonable cause for claiming a charitable contribution
deduction for their contributions to NAT of the facade easement and the
cash and (2) they themselves would testify as to their understanding of
the value of the facade easement and their good faith belief that their
contribution was a qualified conservation contribution under section
170(h)(1).

Because petitioners raise genuine issues of material fact
regarding the applicability of the reasonable cause exception to the
accuracy-related penalties, we shall deny the motion with respect to
those penalties.

V. Conclusion

For the reasons stated, we shall grant the motion with respect to
the facade easement contribution. With respect to the cash contribution
and the penalties, we shall deny the motion.

An appropriate order will be issued.

FOOTNOTES

1 Unless otherwise stated, section references are to the
Internal Revenue Code in effect for the years in issue, and Rule
references are to the Tax Court Rules of Practice and Procedure. We
round all amounts to the nearest dollar.

2 That is, half the amounts under sec. 6662(h) in the
table above.

3 Previously, in October 2003, as part of their
preservation restriction agreement application, petitioners had made a
$1,000 "good faith deposit".

4 The other requirement is that the contribution
be to a "qualified organization". See sec. 170(h)(1)(B). Respondent
concedes that, at the time of the contributions, NAT was a qualified
organization under sec. 170(h)(3).

5 We therefore need not address respondent's
additional arguments that we should disallow the charitable contribution
deduction for the facade easement contribution.

6 Respondent does not explicitly allege fraud or
collusion. That is, he does not state (although he implies) that the
cash contribution was a payment to NAT for its compliance in helping
petitioners claim a deduction for the facade easement -- a deduction
that, respondent implies, both NAT and petitioners knew was illegitimate
because the facade easement itself was worthless. Nonetheless, even if
respondent did so argue, petitioners have alleged enough facts to raise a
genuine issue as to fraud or collusion.

7 Respondent also argues that petitioners may
not, as a matter of law, rely on the substantial authority exception
under sec. 6662(d)(2)(B)(i). Because we find that petitioners have
raised a genuine issue of material fact as to the applicability of the
reasonable cause defense, we need not address the substantial authority
exception.

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Comments

Actually, passing bill in the senate is not an easy task.If you prefer a challenge, attempt getting our Senate to agree unanimously over a bill. Precisely what has not fully passed the Senate yet is the financial reform bill. Cloture wasn't in a position to move across the Senate either. Cloture essentially applies limitations and time limits on how long the Senate can debate and how long each representative can speak their views. Cloture generally helps the senate come to a speedier consensus without using all of the lasting debates. Without the majority, well 2/3, of the Senate wanting to enable cloture, it won't occur. Even though most was for this, the mandatory two thirds of the Senate were not. Who knows the length of time this discussion is going to continue now.

Actually, a facade easement is variety of conservation easement. See IRC sec. 170(h). It's in Point II of the Discussion section of the Kaufman opinion, above. As Mr. Johnson notes, there are other types of conservation easements as well.

This article was improperly titled as a CONSERVATION EASEMENT, when in fact it was a FACADE EASEMENT. This is an important distinction for those of us who recommend conservation easements, but shy away from Facade easements.
A. Johnson
Chadds Ford, PA